The Subprime Mess, Housing Market, and Consumer Debt

The Smart Profits Report: Issue #488
Wednesday, January 16, 2008

Three Monkeys on the Economy’s back
by Martin Denholm
Managing Editor, Smart Profits Report

Just two weeks into 2008, the stock market resembles an old jalopy, stumbling and bumbling its way downward. So far this year, the three major stock indexes - the Dow Industrials, Nasdaq Composite and S&P 500 - are down 5.9%, 8.8% and 5.9% respectively.

It’s not hard to see why. Even the most fearsome beast would struggle to swat away a hail of bullets. Today, I’m going to take a quick look at the subprime mess, housing market, and consumer debt issues then give you a way to protect yourself. So let’s get going…

The Subprime Mess, Housing Market, and Consumer Debt

Even before the champagne popped and 2008 rolled in, the stock market was buckling under the weight of some of the most serious issues to hit Wall Street in quite some time. For example…

The Subprime Mess: Is there any end to this fiasco? The bad news keeps on coming. Last week, Countrywide (NYSE: CFC) reported a $772.7 million fourth-quarter loss ($9.99 a share) - $723.1 million ($0.64 a share) more than in Q4 2006. Fortunately, Bank of America (NYSE: BAC) is willing to bail it out, with a $4.1 billion buyout. BoA CEO Ken Lewis says talk of Countrywide’s demise is a “malicious rumor.”

Just today, Citigroup (NYSE: C) reported a $10 billion fourth-quarter loss (the biggest in its 196-year history), slashed its dividend by 41% (from 54 cents per share to 32 cents), and slashed another 4,200 jobs, in addition to the 17,000 pink slips it dished out last spring. It will receive a further $12.5 billion in new investment, following the $7.5 billion it received in November from the Abu Dhabi Investment Authority.

Merrill Lynch (NYSE: MER) said it will receive a cash injection of $6.6 billion from three foreign funds (The Korean Investment Corp, Mizuho Corporate Bank and Kuwait Investment Authority) in order to offset some of the losses it’s racked up in the subprime market.

On a related theme…

The Housing Market: The downturn continues. Bank foreclosures soared 94% in October and in calling for a 10% drop in average house prices from their peak, Fannie Mae says the correction will last another two years and could be the “toughest housing correction in our lifetimes.”

Consumer Debt: It doesn’t help that consumers keep borrowing money like there’s no tomorrow. Total consumer credit now stands at a whopping $2.5 trillion, according to the Federal Reserve’s latest report - and that doesn’t even include mortgage debt.

That’s an enormous burden - and if consumers stop spending, the economy will be in trouble, given that two-thirds of GDP growth comes from consumer spending. This year, retail sales are forecast to rise just 3.5%, which would be the weakest since 2002.

I could go on - but you get the idea. And this news has triggered the biggest bear of them all…

Recession: The Dreaded “R” Word

According to Merrill Lynch, the U.S. economy is already in recession. They’ve vaulted past all the media pundits, who are still breathlessly debating the issue, and gone straight for the conclusion.

This includes the National Bureau of Economic Research (NBER), who said last week that a U.S. economic recession is now “more likely than not.” I know the financial world is littered with useless, attention-seeking soundbytes, but this one comes from the only group that officially confirms a recession.

Merrill’s report said that December’s pathetic job report, which showed just 18,000 new non-farm jobs created during the month and the unemployment rate edging up to 5%, was the final nail in the coffin.

The question is: What do we do about it?

The Best Hedge Against the Subprime Mess, Housing Market, and Consumer Debt

High oil prices? Check - $91.62 a barrel, to be exact.

A falling dollar? Check. The U.S. Dollar Index is now trading in the mid-70s, with the euro almost at the $1.50 mark. The dollar is likely to weaken further if (or more likely when) the Federal Reserve cuts interest rates again. Chairman Ben Bernanke all-but guaranteed this last week.

Weakening GDP growth? Check. The Organization for Economic Cooperation and Development has lowered U.S. GDP growth from 2.2% in 2007 to 2% this year. The guys at the Blue Chip Economic Indicators are a tad more positive, with a 2.4% forecast, but still down from 2.6%

A tumbling stock market? Umm… check!

To most people, that’s a nasty-looking list. But to gold bugs, it’s heaven. The gold market thrives under such stress - as shown in the metal’s climb to an all-time high of $913.70 an ounce on the NYMEX today. And with the Fed set to cut rates again, gold should become even more attractive if the move triggers an inflation spike.

Gold clearly now has $1,000 an ounce in its sights - something our commodities expert Lee Lowell said in the January Xcelerated Profits Report issue: “Like the oil market, gold is prone to speculation, and with hedge funds looking for another way to score gains, it’s certainly possible that we’ll see prices surge to $1,000 per ounce.”

He also noted it in my column here on July 30, 2007. Back then, I suggested two options if you wanted exposure to the gold market: the streetTracks Gold Shares ETF (NYSE: GLD) and the Market Vectors Gold ETF (AMEX: GDX). Since then, GDX has risen 28.2%, while GLD hit a 52-week high of $90.35 today and is up 35%.

GLD isn’t the only one. Other gold companies that just hit 52-week highs include: Newmont Mining (NYSE: NEM), Barrick Gold (NYSE: ABX), AngloGold Ashanti Ltd (NYSE: AU) and Randgold Resources Ltd (Nasdaq: GOLD).

And this coming Friday, the Xcelerated Profits Report will bank a maximum 17.6% win on Goldcorp (NYSE: GG) when the call options expire. Goldcorp is one of the world’s largest gold producers and also hit a new 52-week high on Monday.

Gold is headed for $1,000. I think it will get there by the end of the first quarter, possibly sooner, depending on what the Fed does.

Best regards,

Martin Denholm

P.S. Another sector that should fare well during an economic downturn/recession is healthcare. We’ve been banging the drum here for several months, taking 99% gains on the first half of our BioMarin (Nasdaq: BMRN) position and well-placed with others. You see, even if the economy and stock market struggles, people don’t stop getting sick and they still need their medicine and drugs. My colleague Marc Lichtenfeld just returned from the JP Morgan Healthcare Conference and picked up several potential investment recommendations. He just sent me this note: “It’s a very exciting time to follow healthcare stocks. Small-cap biotechs provide ample opportunity for outperformance and there are some terrific advances being made in all kinds of maladies. I’ll have a play for the March XPR issue - one of the smartest most well-connected guys I know on the Street is heavily involved with this stock and I think it has enormous potential.”

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